Loss provisions – the difference between IFRS and Basel II
This is a short post to highlight the different loss provisioning principles between IFRS and Basel.
Basel objectives are to ensure the Bank has sufficient provisions to absorb “expected losses” and sufficient capital to absorb “unexpected losses”.
IFRS objectives are to ensure that the financial statements of the bank reflect the true financial position of the company at each “balance sheet date” – this includes loss provisions that recognize a trigger event that has already occurred that will lead to a loss.
The different requirements are a “bit of a headache” for Banks. The Basel requirement and hence the regulatory requirement is forward looking and is premised on past experiences predicting future losses – in order to undertake this exercise, Banks have generally spent millions of dollars establishing sophisticated models to calculate expected loss. These models can’t always be utilized for IFRS purposes and Banks have to either modify their regulatory models or build alternative models.
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Could you please give your opinion on which of the two is better for economic decision making, and, whether you think it would be feasible or desirable to consolidate one system of measurement for both risk management and external reporting, and if so would it be closer to basel or ifrs? Thanks
Could you also explain the relationship between the expected loss ($/year (from PD (%/year) times LGD (%) times EAD ($))) and provisions $. The units don’t match, to get from EL to provisions requires multiplication by a period of time.
Hi David, Im not sure how feasible it would be to have one consolidated means of evidencing loss reserves given the two different objectives. What would make sense is to utilise standard measurements across both standards ie. a default on a loan is measured as 30 days in arrears under IFRS and 90 days under Basel.
Re. your second post. Im not sure you should look at Expected Loss as the measure of recorded provisions. Expected Loss is utilised to meet capital adequacy. Under Basel, Banks has some concessions where the two don’t match, if there is a shortfall, a Bank must deduct the amount from its Capital. I plan to touch on this later.
The use of an expected loss model as a suitable alternative is currently under consideration
@David Hillary –
Bob Herz, the Chairman of FASB, made a speech a week or so ago… Here a few points he made:
“… a single accounting or reporting treatment may not properly achieve the objectives of both the regulators and reporting to investors and the capital markets.”
“Recognizing the potential benefits that could result from having a single set of high-quality accounting standards across the global capital markets, we have devoted substantial time and effort in recent years to working with the International Accounting Standards Board on jointly improving and converging our respective standards through developing common standards in major areas and eliminating differences between our standards.”